Citigroup's (C) stock has declined slightly over the last 3-months. However, the stock is still up over 37% for the year. Keeping in mind the pessimism about the financial sector, the stock has done exceptionally well. Nonetheless, the stagnant price over the past three months indicates that the stock is fully valued at the current price levels and the news has almost completely baked in the valuation. The market is waiting for something positive to come for the company in the short-term. Keeping aside the short-term perspective, I believe Citigroup is a solid investment for the long-term, and the stock is nowhere near its true potential. As the economic conditions get better, the company is well positioned to take advantage of increasing confidence in the financial sector and the overall health of the economy.
Is commodities trading the answer?
Being a big lender, Citigroup has been trying to entice customers from mortgage financing segment with lower down-payment requirements. However, this move is not helping the company as the customers are kept off because of higher interest rates. Its competitors have been facing the same situation. To compensate for this, the bank is now increasing its presence in the commodity business. Ironically, Citigroup is doing this at a time when its competitors are retreating from the market. Commodity market has always been a high risk market as the prices of commodities are relatively harder to predict, which many a times leads to losses or low profit margins. Despite this fact, Citigroup has overseen this challenge and hoping to succeed in this market. However, the confidence and aggression in its move makes a man wonder if Citigroup knows something of which its competitors are unaware. To boost its fortune in the commodity market, the company is increasing its workforce with the expertise in this segment by 15%, about 80% of which are going to be Salesforce.
Double Impact: Cutting Costs and Improving Revenues
On the other side of the picture, the company is implementing cost reduction strategies and focusing on ways to grow its revenue. For Citigroup, the fourth quarter revenue from capital markets and investment banking will probably fall short of the last year's final three months. However, the fourth quarter results from investment banking will probably be higher than the last quarter because of the mergers and acquisitions and equity underwriting. Also, the company does not expect to benefit in this period, as it did in the third quarter, from releasing reserves it had taken for losses on mortgage loans in North America. Banks across the industry have been benefiting from improving credit quality. Last quarter, Citigroup benefited from a $300 million reserve release. Citigroup does not expect a similar reserve release in the fourth quarter.
Furthermore, the legal costs are expected to stay higher. However, the core operating expenses are showing somewhat a downward trend. A very important and encouraging factor for the financial sector is an increase in the interest rates. It will result in widening the interest margin (core business) for the banks. However, the Federal Reserve has decided to keep the short-term interest rate near to zero, which means that the banks will have to pay a lower rate to depositors, resulting in even higher margin for banks. The financial sector is not completely out of trouble - however, most of the banks have been able to get rid of the demons of 2008 financial meltdown. Citigroup will also benefit from its global presence as majority of the bank's revenues come from overseas, and its presence in emerging markets is hugely positive as those economies are still showing impressive economic growth.
I like to value banks on the book value as most of the assets are sellable at the value reported and do not include the affects of depreciation or amortization. In order to further make things transparent, I like to deduct intangible assets (Goodwill etc), which results in tangible book value. The tangible book value of Citigroup is $56.27 per share. The stock is trading close to $50 - it is trading at a discount of close to 10% to its tangible book value. I believe the stock is destined to go up over the next two-three years. However, in the short-term, investors may have to be patient as the price has been somewhat stagnant over the past three months.